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# CH33 - CHAPTER 33 Mergers Answers to Practice Questions 1 2...

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CHAPTER 33 Mergers Answers to Practice Questions 1. Answers here will vary, depending on student choice. 2. Answers here will vary, depending on student choice. 3. a. This is a version of the diversification argument. The high interest rates reflect the risk inherent in the volatile industry. However, if the merger allows increased borrowing and provides increased value from tax shields, there will be a net gain. b. The P/E ratio does not determine earnings. The efficient markets hypothesis suggests that investors will be able to see beyond the ratio to the economics of the merger. c. There will still be a wealth transfer from the acquiring shareholders to the target shareholders. 4. Start with the market value of the combined firm and subtract the market value of the acquiring firm pre-merger. This is the gain from the merger. The cost of the merger can be determined in the following way. First, determine what percentage of the combined firm the target shareholders now own as a result of receiving shares. Now multiply this percentage by the market value of the combined firm. This is the cost of the merger using post-merger pricing. 5. Suppose the market value of the acquiring firm is \$150 million and the value of the firm with a merger is \$200 million. If the probability of a merger is 70%, then the market value of the firm pre-merger could be: (\$150 × 0.3) + (\$200 × 0.7) = \$185 million If the acquiring managers used this value, they would underestimate the value of the acquisition. 6. This is an interesting question that centers on the source of the information. If you obtain the information from someone at Backwoods Chemical whom you know has access to this valuable information, then you are guilty of insider trading if you act upon it. However, if you come across the information as a 58

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result of analysis you have done or research you have performed (which anyone could have done, but did not do), then you are free to act upon the information.
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